How do banks benefit from long balance transfer offers?

By Benjamin Salisbury

You've likely heard about the "balance transfer war" going on
between banks. The longest 0% deals on the market have reached 40 months, and
many offer three years or more. The lengthy deals have inspired millions of
balance transfers in the last few years. Giles Mason, senior press officer for the
UK Cards Association, says there were 6 million transfers in 2014, worth just over £13.1 billion.
The average transfer is approximately £2,200. But what's in it for the banks?

Back in
the 1990's, when these products were introduced, the normal interest-free term
was around six months. Providers hoped customers would stay after that term
ended, but if they left, the card company would not lose too much money.

With the
longer deals, though, this no longer holds true. Banks
and credit card companies lose money from taking on a balance transfer debt
because they pay interest on the money that was lent to the cardholder. However,
issuers rely on a number of other factors to make money, Andrew Hagger, founder
and director of MoneyComms, said in an emailed response to questions.

1. Staying
ahead of the competitionThe simplest answer: to stay at the top of the competition.

"I
think [one] incentive is simply to remain competitive in the best-buy
tables
and hopefully pick up new customers who deliver profitable outcomes," Hagger said.

2. Transfer feeCompanies
get some funds back through a balance transfer fee, which applies to the entire
balance you're transferring. This fee can be less than a month's worth of
interest, and, since it is added to the credit card balance and does not come
directly out of your pocket, it feels like a relatively pain-free charge.

However, depending on how much money you're transferring, it
can add nearly £100 to your balance. For instance, if you transfer a balance of
£3,000 and the balance transfer fee is 2.95%, you'll pay £88.50.

3. Customers that exceed, negate the 0% deal
The card company may hope that you use the card to make purchases without
paying them off, so that you pay (often high) interest on them. More so,
however, they are counting on some customers exceeding or negating the 0% deal.

First,
if you don't repay the balance by the expiry of the 0% deal and don't switch
the balance to a new card, you'll end up paying the standard interest on your
remaining balance, said Hagger.

"Before
the introductory rate ends, we clearly state any changes in price in the
customer's statement, so they are always free to leave when their low rate deal
ends, with no barriers to exit," Carol Thompson,
a consumer finance spokeswoman for Halifax, said in an emailed response to
questions. "We provide clear and transparent information to help
customers understand the terms and duration of the introductory rate."

Banks
also benefit if you miss a payment, exceed your credit limit or negate the
balance transfer deal in any way. In that case, Hagger said, the 0% deal is
terminated immediately and your balance begins accruing interest. This may be
banks' biggest benefit from extending 0% balance transfer offers.

A report published in January 2016 from the
Co-operative Bank found 25% of the
15.6 million Brits who have taken advantage of a 0% balance transfer credit
card in the last five years have fallen foul of the terms of the offer, and had
the promotional 0% rate withdrawn. As a result, UK cardholders have paid up to £1.2 billion
annually in interest.

Additionally,
making a late payment or exceeding your credit limit both come with their own,
separate fees. Typically, it's about £12 for
either. Either slip-up could affect your credit score as well, making it
difficult for you to get a different credit card -- meaning you're stuck with
your now high-interest card.

4. Opportunity
to offer you more products
Even if you benefit from the 0% deal in its entirety, the card company has the
opportunity to sell you new products when the deal ends. These products could
still be beneficial to you, but they still allow the company to make money.

"We always aim to offer attractive products that are valued
by our customers and that deliver a fair return to the company," said a
spokesperson from Virgin Money.

"Attractive
offers for new customers are a feature of the extremely competitive nature of
this market," said Halifax' Thompson.

Be smart with 0% balance
transfer offers
It is important to remember that a credit card company only has to offer its
top promotions to 51% of cardholders. This means almost half of applicants
won't get the headline rate, but could be offered a less competitive rate or
not accepted at all.

"All
the different costs associated with a balance transfer will be set out in the
summary box for each individual card," says Mason, of the UK Cards Association.
It's vital to read all the terms and conditions before you apply, and again
when you receive your card so you can maintain your offer without any nasty
surprises.